Midterm 2 Terms Flashcards
Long-term debt
probable future sacrifices of economic benefits arising from present obligations that are not payable within a year or the operating cycle of the company, whichever is longer
A bond arises from a contract known as a _____ __________.
bond indenture
Bonds backed by a pledge of some sort of collateral
Secured bonds
A debenture bonds is __________
unsecured
Bond issues that mature on a single date are called _______ bonds
term
Issues that mature in installments are called ______ bonds
serial
________ maturing bonds are frequently used by school or sanitary districts, municipalities, or other local taxing bodies that receive money through a special levy
Serially
________ bonds give the issuer the right to call and redeem the bonds prior to maturity
Callable
If bonds are convertible into other securities of the corporation for a specified time after issuance, they are _____________ bonds
convertible
Two types of bonds developed in an attempt to attract capital in a tight money market:
commodity-backed bonds and deep-discount bonds
_________-_______ bonds are redeemable in measures of a commodity
commodity-backed (also called asset-linked)
Sold at a discount that provides the buyer’s total interest payoff at maturity
deep-discount (zero-interest depenture) bonds
bonds issued in the name of the owner are ___________ bonds
registered
a ______ or ________ bond is not recorded in the name of the owner and may be transferred from one owner to another by mere delivery
bearer; coupon
_______ bonds pay no interest unless the issuing company is profitable
Income
Interest on these is paid from specified revenue sources
Revenue bonds
Interest rate written in terms of the bond indenture
stated
coupon
nominal
The rate of interest actually earned by the bondholders is called the ____________ _________ or ________ _______
effective yield; market rate
The investors receive interest at the stated rate computed on the face value, but they actually ____ at an effective rate that exceeds the stated rate because they paid less than face value for the bonds
earn
Because of its relation to interest, companies amortize the ______ and charge it to interest expense over the period of time that the bonds are outstanding
amortize
Amortizes a constant amount each interest period
straight-line method
Amortization of a discount _______ interest expense
increases
Amortization of a premium _________ interest expense
decreases
Whether callable or not, a company must amortize any premium or discount over the bond’s life to ________ because early redemption is not a certainty.
maturity
When companies issue bonds on other than the interest payment dates, buyers of the bonds will pay the seller the interest accrued from the last interest _________ date to the date of issue.
payment
Effective-interest method (present value amortization)
- Compute bond interest expense first by multiplying the carrying value of the bonds at the beginning of the period by the effective-interest rate.
- Determine the bond discount or premium amortization next by comparing the bond interest expense with the interest (cash) to be paid.
The effective-interest method produces a periodic interest expense equal to a _______ percentage of the carrying value of the bonds
constant
Both the effective-interest and straight-line methods result in the same ________ amount of interest expense over the term of the bonds
interest
Discount on bonds payable is not an asset. It is a _______ _______ and a liability valuation account.
contra account
Premium on bonds payable is a ________ _______ and a liability valuation.
adjunct account
Extinguishment of debt
payment of debt
The amount paid on extinguishment or redemption before maturity, including any call premium and expense of reacquisition
reacquisition price
Amount payable at maturity, adjusted for unamoritzed premium or discount, and cost issuance
Net carrying amount
Any excess of net carrying amount over the reacquisition price is a ______ from extinguishment
gain
Excess of reacquisition price over the net carrying amount is a ______ from extinguishment
loss
At the time of the reacquisition, the unamortized premium or discount, and any _____ of issue applicable to the bonds, must be amortized up to the reacquisition date.
costs
Replacement of an existing issuance with a new one
refunding
Like a bond, a ____ is valued at the present value of its future interest and principal cash flows. The company amortizes any discount or premium over its life, just as it would the discount or premium on a bond.
Note
For a zero-interest-bearing note, the implicit _______ rate is the rate that equates the cash received with the amounts to be paid in the future.
interest
When exchanging debt instrument for property, goods, or services in a bargained transaction entered into at arm’s length, the stated interest rate is presumed to be fair unless:
- No interest rate is stated, or
- The stated interest rate is unreasonable, or
- The stated face amount of the debt instrument is materially different from the current cash sales price for the same or similar items or from the current fair value of the debt instrument.
If there is no ______ rate of interest, the amount of interest is the difference between the face amount of the note and the fair value of the property.
stated
Process of interest-rate approximation is called
imputation (hence the imputed interest rate)
Fair value option
noncurrent liabilities, such as bonds and notes payable are recorded at fair value, with unrealized holding gains or losses reported as part of net income
the net change in fair value of the liability from one period to another, exclusive of interest expense recognized but not recorded
unrealized holding gain or loss
Attempt to borrow monies in such a way to prevent recording the obligations
off-balance-sheet financing
Forms of off-balance-sheet financing:
- Non-consolidated subsidiary
- Special-purpose entity (SPE)
- Operating leases
Debt to assets ratio measures:
the percentage of the total assets provided by creditors
Times interest earned ratio indicates
the company’s ability to meet interest payments
FASB believes that _____ _______ measurement for financial instruments, including financial liabilities, provides more relevant and understandable information than amortized cost.
fair value
Note _________ generally indicate the nature of the liabilities, maturity dates, interest rates, call provisions, conversion privileges, restrictions imposed by the creditors, and assets designated or pledged as security.
disclosures (and fair value and future payments for sinking fund of the debt should be disclosed)
Why would a company wish to reduce its bond indebtedness before its bonds reach maturity? Indicate how this can be done and the correct accounting treatment for such a transaction.
It is sometimes desirable to reduce bond indebtedness in order to take advantage of lower prevailing interest rates. Also the company may not want to make a very large cash outlay all at once when the bonds mature. Bond indebtedness may be reduced by either issuing bonds callable after a certain date and then calling some or all of the, or by purchasing bonds on the open market and then retiring them.
How are gains and losses from extinguishment of a debt classified in the income statement? What disclosures are required of such transactions?
Gains/losses from extinguishment of debt should be aggregated and reported in income. For extinguishment of debt transactions disclosure is required for the following:
- a description of the transactions, including the sources of any funds used to extinguish debt if it is practicable to identify the sources
- the income tax effect in the period of extinguishment
- the per share amount of the aggregate gain/loss net of related tax effect
What disclosures are required relative to long-term debt and sinking fund requirements?
The required disclosures at the balance sheet date are future payments for sinking fund requirements and the maturity amounts of long-term debt during each of the next five years
Why might a company be interested in using off-balance-sheet financing?
- many believe removing debt enhances the quality of the balance sheet and permits credit to be obtained more readily and at less cost
- loan covenants are less likely to be violated
- the asset side of the balance sheet is understated because fair value is not used for many assets. As a result, not reporting certain debt transactions offsets the nonrecognition of fair values on certain assets
What are some forms of off-balance-sheet financing?
- investments in non-consolidated subsidiaries
- use of special purpose entities
- operating leases
FASB Accounting Standards Update: Interest - Imputation of Interest recommends that debt issue costs be presented in the BS as a direct…
deduction from the carrying amount of debt liability, consistent with effective-interest amortization of debt discounts or premiums
Foreign currency ____ arises when a U.S. company engages in transactions settled in another currency
risk
Risk occurs because the US company is uncertain about the US dollar ______ of transactions in the future
value
What happens when US company makes a credit sale to customers at a price denominated in foreign currency units and dollar value of the receivable changes before the payment is received and converted into dollars?
exchange gains or losses will be generated
Accounting Procedures for Import/Export Transactions
- Restate invoice price into dollars using the spot rate at the transaction date
- If the transaction is not settled at balance sheet date, record an exchange gain/loss by adjusting the receivable/payable to its dollar equivalent using the spot rate at the balance sheet date
- When the currency is received/paid, adjust the receivable/payable and close it out
Importer loses bc it takes more US dollars to pay the supplier
and
exporter gains because the pounds received from the UK customer are converted into more US dollars
When the US dollar weakens against the pound (US dollar rate increases)
What exchange rate should be used for interest-bearing investments and notes payable?
Interest income and expense are converted using the spot rate when the interest is accrued
Importers and borrowers have _______ denominated in another currency
liabilities
Importers and borrowers face risk that the direct exchange rate will ____
rise
requires more dollars to purchase the foreign currency to pay obligation
Exporters and lenders have _____ denominated in another currency
assets
Exporters and lenders face risk that the direct exchange rate will ____
fall
causing the receipt of fewer dollars on conversion than the amount owed
Holding a receivable or payable
exposed position
Agreement to buy or sell merchandise in the future
firm commitment
Buying or selling from/to foreign customers on a recurring basis
Forecasted transactions
Deliberate exposures through forward contracts or other instruments
speculative investments
Method of neutralizing risk by trading in the forward, futures, or options market
hedging
Hedging removes the ________ involved in not knowing how many dollars will be paid or received
uncertainty
A financial instrument that derives its value from some other financial item
derivative instruments (forward and futures contracts)
Individual contracts negotiated with dealers
forward contract
Hedges of exposed positions or firm commitments
fair value hedges
hedges of forecasted transactions
cash flow hedges
gains and losses due to unhedged exposure reported in the income statement as exchange rate changes
Partial hedges of foreign exchange risk
Contracted forward rate - Current forward rate =
Fair Value
An _____ in the forward rate gives us the ability to buy the currency for less than its current value, an advantage or asset
increase
A ________ in the forward rate means that we must buy the currency for more than its current value, a disadvantage or liability
decrease
A forward sale contract requires the holder to sell foreign currency at a specified time in the future for a ______ price
known
If the dollar contract value to be received is higher than the current value of the currency to be delivered, the investment in forward contract is an _____.
asset
Qualified hedges
1) Must be documented as hedging a specific and recognized financial risk, AND
2) Must be effective in neutralizing risk
Extent to which the hedge instrument neutralizes the financial risk
Hedge effectiveness
Hedge effectiveness ration =
Change in fair value of hedge instrument / change in fair value of hedged item
Total number of shares authorized by the state of incorporation for issuance
Authorized capital stock
Total number of shares authorized but not issued
Unissued Capital Stock
Total number of shares issued (distributed to stockholders
Issued capital stock
Total number of shares issued and still in the hands of stockholders
Outstanding capital stock (issued less treasury stock)
Shares of stock issued and repurchased by the issuing corporation but not retired
Treasury stock
The direct costs of issuing stock, such as underwriting costs, accounting and legal fees, printing costs, and taxes, should be reported as a ____________ of the amounts paid in
reduction
Issue costs are ______ to APIC - CS because they are unrelated to corporate operations
debited
Proportional Method (of allocating proceeds)
If the fair value or other sound basis for determining relative value is available for each class of security, the company allocates the lump sum received among the classes of securities on a proportional basis
Companies should record stock issued for services or property other than cash at the fair value of the _____ _______ or fair value of the _______ consideration received (whichever is more clearly determinable)
stock issued; noncash
Watered stock
Created by the overvaluation of the SE resulting from inflated assets
Secret reserves
When a corporation undervalues its recorded assets
Types of Dividends
Cash dividends
Property dividends
Liquidating dividends
Stock dividends
All dividends, except for stock dividends, ______ the total SE in the corporation
reduce
Small stock dividends
Less than 20-25% of the common shares outstanding
A stock dividend results in the transfer from retained earnings to PIC of an amount equal to the ____ _____ of each share (if the dividends is less than 20-25%) or the par value of each share (if the dividend is greater than 20-25%).
fair value
Nonparticipating means the security holder is entitled to no more than the specified fixed ________.
dividend
A fully ________ security shares pro rata with the common stock dividends declared without limitation.
participating
_______ means dividends not paid in any year must be made up in a later year before any profits can be distributed to common stockholders
Cumulative
Possible sources of APIC:
- issuance of CS or PS in excess of par premiums on stock issued
- sale of treasury stock above cost
- recapitalizations or revisions in the capital structure
- conversion of convertible bonds or PS
- declaration of a small stock dividend
Right to share proportionately in any new issues of stock of the same class
Preemptive right
The preemptive right protects and existing ________ from involuntary dilution of ownership interest.
dilution
The residual corporate interest that bears the ultimate risks of loss and receives the benefits of success
Common stock
Sacrifices some of the inherent rights of common stock ownership in return for special preference
Preferred stock
The earned capital of the company
Retained earnings
Amount provided by stockholders to the corporation for use in the business
Contributed (paid-in) capital
Capital that develops from profitable operations
Earned capital
Cumulative net contributions by stockholders plus retained earnings
Stockholders’ equity
Any excess over par value paid in by stockholders in return for the shares issued to them
Additional Paid-in Capital
Issuance of no-par stock avoids the contingent ______ that might occur if the corporation issued par value stock at a discount
liability
Stated value
minimum value below which a company cannot issue stock
Proportional Method
If the fair value or other sound basis for determining relative value is available for each class of security, the company allocates the lump sum received among the classes of securities on a proportional basis.
Incremental Method
It uses the fair value of the securities as a basis for those classes that it knows, and allocates the remainder of the lump sum to the class for which it does not know the fair value.
Leveraged buyout (LBO)
A company borrows money to finance stock repurchases - to take a company private
Results in debiting the TS account for the reacquisition cost and in reporting this account as a deduction from the total PIC and retained earnings on the balance sheet.
Cost Method for Purchase of TS
Records all transactions in treasury shares at their par value and reports the TS as a deduction from capital stock only
Par (stated) value method for Purchase of TS
Any passed dividend on cumulative preferred stock constitutes a dividend in ______.
arrears
Dividend not based on retained earnings
Liquidating dividends
A declared cash dividend is a _______.
liability
Dividends payable in assets of the corporation other than cash
Property dividends (or dividends in kind)
Issuance by a corporation of its own stock to its stockholders on a pro rata basis, without receiving any consideration
Stock dividend
Small stock dividends
less than 20-25%
Restrictions on RE are best disclosed by ____.
note
Return on common stock equity (Return on equity) measures:
Profitability from the common stockholders’ viewpoint
Ratio of cash dividends to net income
Payout ratio
Amount each share would receive if the company were liquidated on the basis of amounts reported on the BS
Book value per share
Classify a debt security as ___________________ only if it has both positive intent and ability to hold securities to maturity
held-to-maturity
HTM is accounted for at ______ cost on the BS
amortized
Report Available-for-Sale securities at:
fair value
Motivations for investing in securities:
- to earn a high rate of return
- to secure certain operating or financing arrangements with another company
US government securities, municipal securities, corporate bonds, convertible debt, and commercial paper are all types of what?
Debt securities
Debt securities that the company has the positive intent and ability to hold to maturity
Held-to-Maturity
Debt securities bought and held primarily for sale in the near term to generate income on short-term price differences
Trading
Debt securities not classified as held-to-maturity or trading securities
Available-for-Sale
Price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date
Fair value
Companies report AFS securities at fair value on the BS but do not report changes in fair value as part of net income until after _______ the security.
selling
The use of the ____ _____ ____________ account enables the company to maintain record of its amortized cost.
Fair Value Adjustment
Selling the winners and holding the losers
Gains trading
Companies report trading securities at ____ _____, with unrealized holding gains and losses reported as part of net income.
fair value
The net change in the fair value of a security from one period to another
Holding gain or loss
_______ ________ represent ownership interests such as common, preferred, or other capital stock.
Equity securities
Valuation method used when investor has holdings of less than 20%? aka passive interest
fair value method
Valuation method used when investor has holdings between 20-50%? aka significant influence
equity method
Valuation method used when investor has holdings of more than 50%? aka controlling interest
consolidated statements
Impairment
loss in value that is other than temporary
What type of adjustment is necessary to ensure that gains and losses are not counted twice when a sale occurs?
A reclassification adjustment
Securities that may reduce EPS upon exercise
Dilutive securities
Bonds that can be changed into other corporate securities during some specified period after issuance
Convertible bonds
Certificates entitling the holder to acquire shares of stock at a certain price within a stated period
Warrants
Can be separated from the stock and traded as a separate security
Detachable stock warrant
The right to purchase newly issued shares in proportion to holdings
Preemptive privilege (a stock right)
Gives key employees the option to purchase common stock at a given price over an extended period of time
Stock option
Grant date
The date you receive the options
Intrinsic-value method
Measures compensation cost by the excess of the market price of the stock over its exercise price at the grant date
Fair value method
Companies use acceptable option-pricing models to value the options at the date of grant. These models take into account the many factors that determine an option’s underlying value.
These plans transfer shares of stock to employees, subject to an agreement that the shares cannot be sold, transferred, or pledged until vesting occurs.
Restricted-stock plans
Indicates income earned by each share of common stock
Earnings per share
Simple capital structure
consists only of common stock
Complex capital structure
includes securities that could have a dilutive effect on EPS
Number that constitutes the basis for the per share amounts reported
weighted-average number of shares outstanding
Securities that upon conversion or exercise increase EPS
Antidilutive securities
If-converted method assumes:
1) the conversion of the convertible securities at the beginning of the period
2) the elimination of related interest, net of tax
Two main reasons corporations issue convertibles:
- To raise equity capital without giving up more ownership control than necessary
- Obtain debt financing at cheaper rates
Contractual agreement between a lessor and a lessee
Lease
Noncancelable
Means that firm can cancel the lease contract only upon the outcome of some remote contingency, or that the cancellation provisions and penalties of the contract are so costly to the firm that cancellation probably will not occur
In order to record a lease as a capital lease, the lease must be __________.
noncancelable
_______-_________ option allows the lessee to purchase the leased property for a price that is significantly lower than the property’s expected fair value at the date the option becomes exercisable
Bargain-purchase
______-_____ option allows the lessee to renew the lease for a rental that is lower than the expected fair rental at the date the option becomes exercisable
Bargain-renewal
Determining the present value of the minimum lease payments involves three important concepts:
1) minimum lease payments
2) executory costs
3) discount rate
Executory costs
insurance, maintenance, and tax expenses
Advantages of leasing
- 100% financing at fixed rates
- protection against obsolescence
- flexibility
- less costly financing
- tax advantages
- off-balance-sheet financing
Capitalize a lease that transfers substantially all of the benefits and risks of property __________, provided the lease is noncancelable
ownership
Leases that do not transfer substantially all the benefits and risks of ownership are _________ leases
operating
Minimum Lease Payments include:
- minimum rental payment
- guaranteed residual value
- penalty for failure to renew or extend the lease
- bargain-purchase option
Possible advantages to leasing assets instead of owning:
- permits the write-off of the full cost of the assets (including any land and residual value) aka possible tax advantage
- may be more flexible in that the lease agreement can contain less restrictive provisions than a bond indenture
- permits 100% financing of assets
- may permit more rapid changes in equipment, reduce the risk of obsolescence, and pass the risk in residual value to the lessor or a third party
- favorable tax advantages
- potential of off-balance-sheet financing with certain types of leases
Possible disadvantages of leasing instead of owning:
- in an ever-increasing inflationary economy, retaining title to assets may be desirable as to hedge against inflation
- interest rates for leasing often are higher and a profit factor may be included in addition
- in some cases, owning the asset provides unique tax advantages, such as when bonus depreciation is permitted
Two lease accounting methods available for lessees:
- the operating method
- the capital-lease method
The leased asset remains the property of the lessor with the payment of a lease rental recognized as rental expense
Operating method
The lessee treats the lease transaction as if an asset were being purchased on credit; therefore, the lessee sets up an asset and a related liability and recognizes depreciation of the asset, reduction of the liability, and interest expense
Capital-lease method
Periodic payments made by the lessee and received by the lessor. They may include executory costs such as maintenance, taxes, and insurance.
Minimal rental payments
Payments required or expected to be made by the lessee. They include minimum rental payments less executory costs, a bargain purchase option, a guaranteed residual value, and a penalty for failure to renew the lease.
Minimum lease payments
The present value of the minimum lease payments is ________ by the lessee.
capitalized
The PV of the lease payments is computed using the lessee’s incremental _________ rate unless the implicit rate used by the lessor is lower and the lessee has knowledge of it.
borrowing
The ______-_____ method is used to allocate each lease payment between a reduction of the lease obligation and interest expense.
effective-interest
From the standpoint of the lessor, leases may be classified for accounting purposes as:
- operating leases
- direct-financing leases
- sales-type leases
From the standpoint of lessors, a capital lease meets one or more of the following criteria:
- transfers ownership
- contains a bargain-purchase option
- term is equal to 75% or more of the estimated economic life of the property
- PV of the minimum lease payments (excluding executory costs) equals or exceeds 90% of the fair value of the property
A capital lease must meet the following criteria:
1) collectibility of the payments required from the lessee is reasonably predictable, AND
2) no important uncertainties surround the amount of unreimbursable costs yet to be incurred by the lessor
Unguaranteed ______ values are not included in the lessee’s minimum lease payments.
residual
If a bargain-purchase option exists, the lessee must ________ the present value of the minimum lease payments by the PV of the option price.
increase
The incremental costs incurred by the lessor that are directly associated with negotiating, consummating and initially processing leasing transactions.
Initial direct costs
Proper balance sheet presentation for bonds payable =
Face value + unamortized premium
OR
Face value - unamortized discount
